If you have a retirement account such as an IRA, SEP, qualified pension, profit sharing or stock bonus plan covered under ERISA such as a 401(k) or Thrift Savings Plan, you likely have always considered that the dollars in your plan were safely out of the grasp of the Internal Revenue Service. Retirement accounts are protected by law from creditors under the terms of ERISA. Most state laws provide protection as well for your retirement savings assets. The 1992 U.S. Supreme Court decision in Patterson V Shumate cemented the protection in ruling the interest held by Shumate in his employer’s pension plan was excluded as an asset in his bankruptcy estate. Surely with all the protections in place, you can rest easy that your retirement savings cannot be used to settle your outstanding tax debt, for example, with a levy. You couldn’t be more mistaken.
What can be levied?
IRC Section 6331 provides authority for the Service to collect tax by a levy upon all property and rights to property belonging to the individual with the outstanding tax liability. IRC Section 6334 does provide an exemption to this authority for payments such as unemployment benefits, State or local government assistance payments or public welfare programs by which eligibility is determined by a needs test and Supplemental Security Income payments to the aged, blind and disabled. Code Section 6334 does not provide exemption to retirement savings, leaving these assets unprotected from the Service’s ability to levy.
There are strict rules regarding the notices required before the IRS can levy an individual’s retirement account. Provided the required notices have been filed, there is no court approval required for the Service to take the property. The IRS does regard the levy of a retirement account as a “special case” and additional scrutiny and managerial approval are required, limiting the ability to levy a retirement account to revenue officers. Generally speaking, revenue officers are assigned to cases where there is a significant outstanding tax liability.
What does the IRS consider when the decision is being made to levy a retirement account?
The first item of consideration is to determine what property, retirement assets and non-retirement assets are available to collect the liability. The Service will look first towards property other than retirement assets or arranging a payment agreement before issuing a retirement account levy. The cost of pursuing the other assets enters into the decision and decisions are made on a case-by-case basis.
Secondly, the IRS will consider if the taxpayer’s conduct has been flagrant. If the taxpayer has not engaged in flagrant conduct, the retirement account will not be subject to levy. This leads to the question…
Just what is considered flagrant behavior?
The Internal Revenue Manual on levies lists a number of activities as evidence of flagrant behavior. Amongst that list are the following: continuing contribution to retirement accounts during the time period when the taxpayer knew unpaid taxes were accruing; accumulation of unpaid income taxes over multiple tax periods with no adjustment to withholding or making timely and adequate estimated tax payments to prevent future delinquencies; convictions for tax evasion or assisting others in evading tax and a pattern of uncooperative or unresponsive behavior that delays the collection of the tax due.
The final step is to determine whether the taxpayer depends on the money in the retirement account or will have a need in the near future for necessary living expenses. If it is found that the taxpayer will be dependent on the funds in the retirement account, the manual advises a levy not be the course of action. A combination of living expenses as established under the collection standards and life expectancy tables are tools used in the calculation.
National Taxpayer Advocate
The National Taxpayer Advocate (NTA) has expressed concerns regarding the IRS’s ability to levy retirement accounts. There is no definition by the Service as to flagrant conduct. Without that definition, taxpayers simply may not be aware of what constitutes flagrant conduct in the eyes of the IRS; thus, leaving them vulnerable to the risk of retirement account levy. In addition, the NTA indicates that while the Service must perform an analysis as to the taxpayer’s dependency on retirement assets, the calculation requirement is not required to be documented. The calculation does not factor in growth in the funds or projections of increased living expenses. The NTA worries that these deficiencies contribute to the inability of the taxpayer to refute the calculation or ensure that all taxpayers are evaluated on a consistent basis.
Retirement account statistics
Published statistics regarding taxpayers in the 1948 to 1974 age groups indicate that less than 60% of those individuals are significantly funded for life after retirement. Given those statistics, it’s hard to imagine that individuals will not need the retirement assets they hold in their retirement years. It’s obvious that any taxpayer who is at risk of a levy on their retirement assets is in a bad position. As I have done so many other times, I will once again preach to you. Do not ignore the situation you have found yourself in. Hoping it will go away is not an option and given the impact that the loss of your retirement assets could have today and in your “golden” years, you simply must vigilant in your efforts to reach a resolution.
Cheryl Dickerson, CPA